The Financial Sector May Be Setting Up For A More Pronounced Move Higher

By Jim Donnelly, Olson Global Markets

One of the theories widely embraced by many fundamental analysts is that for the overall equity markets to improve in earnest, the financial sector must lead the way up. After all, it was the financial sector that dragged a huge portion of the equity markets down. Further, it is the area of the financial system that has caused credit to be allocated so judiciously of late and as a result represents the stability, or lack thereof, of the economy as a whole. Thus, it is the sector of the market that must lead the way and lift the overall market back to health.

Gloomier assessments of the economy point to the potential for future shocks to possibly derail the financial sector over the intermediate-term. Commercial real estate issues, another round of residential foreclosures, credit card defaults and chronic unemployment levels are all sited as potential potholes. That said, the equity markets tend to be a discounting mechanism and as such have likely priced in a lot of these deep dark scenarios.

From a technical perspective, the Financial Select Sector SPDR Fund, whose ticker symbol is XLF, appears to be basing out in the form of a bullish reverse Head & Shoulders pattern on daily bar charts. Although some technical studies suggest more downside price action is likely over the short-run, intermediate-term prospects look to be very bright by comparison.

At Friday’s close, the XLF stood at $12.04. The key to the bullish reverse Head & Shoulders pattern scenario playing out, however, would be for a solid break above “neckline” resistance (which is now at the $13.10 level) to occur. If that “breakout” happens, a more invigorating move up to the $21 area would likely follow. That, of course, could also trigger a more broad based recovery in equities and catch bears and those with idle cash off guard.

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